INSTITUTE FOR WORLD ECONOMICS HUNGARIAN ACADEMY OF SCIENCES W o r k i n g P a p e r s

(1)

INSTITUTE FOR WORLD ECONOMICS HUNGARIAN ACADEMY OF SCIENCES

W o r k i n g P a p e r s

No. 167 February 2006

András Inotai, Tamás Novák, Miklós Szanyi, Tamás Szemlér

AT A TURNING POINT?

The Southeast European Economies

1014 Budapest, Orszagház u. 30.

Tel.: (36-1) 224-6760 • Fax: (36-1) 224-6761 • E-mail: vki@vki.hu

(2)

F OREWORD

In recent years, politicians and economic-policy decision makers pay increasing attention to the processes in the Southeast European region on account of its diminishing economic and political risks, and accelerating or stabilizing high-level growth, i.e. factors which have all appreciated the area. Consequently, foreign investors show a grow- ing interests in the terrain as they attach high hopes to market opportunities that may yield substantial market expansion and profit gains.

However, despite the undisputable stabilization, the economic processes of the region leave a set of questions open. On the one hand, the conditions of sustainable development have only evolved in the smaller part of the region, while several countries are still being engaged in creating the foundations of economic activity, eliminating serious imbalances and introducing market reforms, on the other. Favourable processes can be enhanced as policies of the European Union towards the region – characterized by ambivalence in the nineties – have become unambiguous. Relations between the EU and Southeast Europe received a sounder framework, although the integration process in most Balkan countries is in an initial phase, yet.

Besides stabilization, the acceleration of privatization processes in the area facilitated the more active presence of foreign investors. In some countries foreign-owned firms or enterprises with foreign participation already contribute to improving the structure of economy and easing unemployment. Hungarian companies enter the region in grow- ing numbers too, though there are only firms of larger size that dominate investment activity, so far. Smaller firms confine themselves to invest in a limited circle of countries.

In our opinion, it must be treated as a priority that Hungary’s relations with South- east Europe should help diversify Hungarian foreign trade and improve the growth prospects of the economy by additional impulses. The analysis of the processes outlined above has belonged to the major research fields of the Institute for World Economics for years. In this number of Working Papers we examine the features of development and the factors influencing investment in the region (Romania, Bulgaria, Croatia, Serbia and Montenegro, Macedonia, Bosnia-Herzegovina and Albania) from the viewpoint of the European integration and the Hungarian economy.

(3)

G ^ROWTH P ROCESSES AND T ^HEIR S USTAINABILITY IN THE S ÔUTHEAST E ÛROPEAN R ÊGION

Tamás Novák

1) S TABILISATION OF THE

S OUTHEAST E UROPEAN REGION

During the past 4-5 years economic stabilisation in the Southeast European countries has been a common feature.

GDP growth rates are relatively high, the rate of inflation is low or it is moderat- ing, foreign direct investments are on the increase due to decreasing regional risks and comparably low production costs.

Despite the quite similar processes in these countries, the region itself is far from being a more or less unified economic area, neither in terms of economic development, nor in international relations. There are huge differences between them regarding per capita income, pace of economic transformation and the potential economic and political risks. In- traregional economic relations continue to be limited in spite of the strong impetus coming from abroad (Stabilisation and Association Process i.e. the objective of establishing regional free trade), and complementarity is very small between production structures. Meeting the accession requirements of the EU are ham- pered by distorted economic structures.

In certain countries technological back-

wardness makes the modernisation of economic structure especially difficult due to extremely high capital requirements (for example Bosnia-Herzegovina, Albania).

The region in economic sense can be considered as a 3+4 structure. Three countries have better prospects for EU accession (Romania, Bulgaria, Croatia), while the prospects for the other four countries are very vague. In economic terms the situation in Romania and Bul- garia in regional comparison is quite good partly due to earlier started transformation and to the increasing adjustment needs associated with the EU integration process. From the economic- situation point of view, the Western Bal- kans require relatively similar handling.

(Croatia is outstanding from this group owing to its economic development level and the stability of its economic structures.)

Although the growth trends in the region are similar, the growth factors may differ from country to country. The first group consists of countries that have stronger market-economic bases and grow quickly, structural reforms are relatively well advanced, FDI inflow is strong and develops capacities for satis- fying export needs or domestic demand.

The countries of this group have concluded EU talks or are already in acces-

(4)

sion negotiations. In their case, in spite of some alarming signs, only the rate of growth is the question. In the second group, countries initiated some reforms in economic transformation under favourable international economic conditions. These reforms are either the starting of longer-term structural reforms, the speeding up of privatisation, or tem- porary artificial business support. The sustainability of artificial business support is questionable and recession can surely be expected in case of a slowdown in reforms or worsening international conditions. To the third group those countries belong that experience positive business cycle as a result of relative stabilisation of regional political environment, international aid and support, and related foreign direct investments. In these countries the long-term real-economic base is miss- ing, the development of production capacities requires a longer time and the results are not certain at all. If aid de- pendence could not be replaced with real-economic base, the economic development cannot be well established in the long run. Between the second and the third group there is no firm demarking line, countries belong to one or the other group alternatively. When judging the potentials of the region an additional aspect is that the business cycle in the region is currently different from the one experienced in Western and Central Europe. The catching up of Central and Southeast European countries with the developed West entails substantial con- vergence process that sooner or later leads to the synchronisation of growth processes, too. The Southeast European region is at the beginning of this con- vergence process which means a substantial growth difference compared with the developed Western European countries.

This situation drives companies in the more developed countries, where growth rates are much lower, to invest into this high-growth region that offers further business opportunities and secure continuous company growth.

While the situation of Romania and Bulgaria is stabilised in the long run by EU membership, the economic development of the Western Balkans, shaped by political and security-policy processes, can be structured along three scenarios that basically determine the prospects for the next 5-6 years.

∗ Large economic setback in the region’s economic development: intensification of regional rivalry, increasing international isolation. The setback may differ from country to county, but this may destroy the region’s favourable perception in the rest of the world. Some countries may drift to the periphery and the integration perspectives worsen.

∗ Step by step integration: internal stability, strengthening of international cooperation, solid internal security situation, continuous fulfilment of accession conditions.

∗ Progressive integration: successful domestic transformation, strengthening regional stability, EU membership, market economy.

Given these framework conditions the economic perspectives for the next years seem to be favourable. Investment expec- tations are positive in the wake of economic stabilisation, advantageous cost factors, expanding markets, and in some cases even privatisation supply is promis- ing.

It is extremely important to note that the majority of Western Balkan countries are entirely depend on foreign transfers.

The efficient transformation of domestic economies at present is not possible from own resources only. That is why the stabilisation and association process and its coordinated donor policy is a most important condition.

(5)

2) G ROWTH PROCESSES

The economic development level of the Southeast European countries heavily lags behind that of the Central European countries. Calculated on purchasing power parity (PPP) per capita GDP in the region ranges from 25% to 47% of EU25 average.

Calculated at current exchange rate, the low development level of the region is even more obvious. According

to the data for 2004, per capita GDP is only 6.5-11% of EU15 average (without Croatia).

The majority of the countries even in 2005 did not reach the pre-transition GDP level, the far- est from which are Serbia and Bosnia. (These two countries suf- fered the largest loss in the middle of the nineties, but their growth performance today is not much better than those of the other countries from the region, thus their relative position cannot improve substantially.)

During the past five years the average growth rate has surpassed 5% in Bul- garia, Romania, Albania, and it was very close to that in Serbia, Macedonia and Bosnia-Herzegovina. However, the simple growth rates can hide some qualitative factors that can significantly modify the judgement of the growth processes.

While some of the countries show a relatively stable growth, in other cases there are significant changes year by year due either to outside business cycle or to modifications in economic policy

(privatisation, domestic demand, etc.). After the stabilisation program introduced in 1997 Bulgaria has en- tered into a sustained and relatively high growth-rate period, as Romania did it after 2001. Albania and Bosnia have developed relatively quickly and without bigger fluctuations during the past few years, but these two countries are the least developed ones in the region. On the other hand, Serbia and FYROM show large fluctuations, unfavourable domestic or foreign processes easily destabilise these countries. After the very fast economic growth in 2004, in 2005 a certain

Table 2

Per capita GDP as % of EU15 average (calculated at exchange rate)

2000 2001 2002 2003 2004 Albania 5.13 6.49 6.70 6.92 7.99 Bosnia-Herzegovina 5.93 6.22 6.38 6.65 6.77 Bulgaria 7.31 8.10 8.61 9.14 9.75

Croatia 19.66 21.09 22.34 23.27 24.30 FYROM 8.39 7.96 8.12 8.20 8.30 Romania 7.84 8.45 9.11 9.44 10.62 Serbia 3.85 6.50 8.25 9.02 9.26 Hungary 21.63 23.96 27.80 29.02 31.23 EU15 100.00 100.00 100.00 100.00 100.00

Source: Own calculation based on Eurostat data Table 1

Per capita GDP as % of EU25 average (PPP)

1991 1995 2000 2001 2002 2003 2004 Albania 10 15 15 19 19 20 20 Bosnia-Herzegovina - - 25 25 26 26 27 Bulgaria 35 31 27 28 29 30 30 Croatia 42 37 41 42 44 45 46 FYROM 30 25 26 24 25 25 25 Romania 37 37 25 26 26 30 32 Serbia - - 24 24 24 24 24

Hungary 51 49 53 56 58 60 61 EU25 100 100 100 100 100 100 100

Source: Eurostat, WIIW

(6)

slowdown took place in the majority of the countries.

3) S USTAINABILITY

The key factor of future development in the whole region is the sustainability of current growth rates. Besides the application of convenient economic policy, the international processes also play an important role (especially the achievement of EU membership or its concrete prom- ise), but the preparedness of the institutions, their capability for change also play a role. This problem does not affect each country equally; e.g. Bulgaria and Romania are more solidly based, not least because of their immediate EU accession, while the bases of the countries of former Yugoslavia are weaker. There can be significantly less problems in those countries where exports and investments play an important role in GDP growth. The basically domestic- consumption-based growth is very sensi- tive in these very small countries to increasing current-account deficit.

During the past years there were significant increases in household consumption in Romania, Bulgaria and Croatia. On the one hand, the growth

of consumption did not crowd out (private) investments, since they were partly supported by the tight budget and the huge foreign- capital inflow. On the other hand, there were significant differences:

while Bulgaria and Romania were able to acquire capital for pro- ductive investments, the investment activity in Croatia concentrated on tourism and highway building, but the technological change in the economy was postponed.

Each country examined is characterised by large or very large unemployment rate and it has not decreased significantly in spite of substantial economic growth. Unemployment data are not very reliable, however. The various methodologies show very different results. All in all, it can be seen that the unemployment rate fluctuates between 30-45% in Bosnia, FYROM and Serbia, and it is also very close to this band in Albania. These data refer to the lack of production capacities, the failed structural change and the weak employment-creating ability of the private sector. In certain countries the official unemployment rates seem to be favourable, but these do not refer to successful adjustment, but rather the continuous postponement of structural reforms that may lead to significant increases in unemployment rates. (This effect is expected to be the largest in Romania.)

While the managing of unemployment is an everyday economic-policy task, in

Table 4 Unemployment rate

(% – LFS)

2000 2001 2002 2003 2004 Albania 16.8 16.4 15.8 15.0 14.4 Bosnia-Herzegovina 38.0 39.2 40.9 42.0 42.8

Bulgaria 16.9 19.7 17.8 13.6 11.9 Croatia 16.1 15.9 14.8 14.3 13.8 FYROM 32.3 30.5 31.9 36.7 37.2 Romania 7.1 6.6 8.4 7.0 8.0 Serbia 12.1 12.2 13.3 14.6 18.5 Source: National statistical offices, central banks

Table 3 Real GDP growth

(%)

2000 2001 2002 2003 2004 2005*

Albania 7.3 7.6 4.7 6.0 5.9 6.5 Bosnia-Herzegovina 5.9 4.5 5.5 3.0 5.0 5.0

Bulgaria 5.4 4.1 4.9 4.5 5.6 5.5 Croatia 2.9 4.4 5.2 4.3 3.8 3.0

FYROM 4.5 -4.5 0.9 2.8 2.9 4.0 Romania 2.1 5.7 5.1 5.2 8.3 5.5

Serbia 5.2 5.1 4.5 2.4 8.6 4.0

* forecast

Source: National statistical offices, central banks,

(7)

the longer run demographic processes can also cause serious problems. This arises from negative population growth, fast increase of the elderly and the visi- ble emigration of the younger generation.

The opposite process, namely the immi- gration, also creates very difficult situation as it is the case in Serbia- Montenegro where the inflow of nearly 700.000 people without employment creation resulted in serious problems.

Inflation shows a favourable trend.

Hyperinflation was everywhere stopped,

and during the last years its rate has became one-digit, but its sustainability is questionable for many reasons. Firstly, the moderation of inflation was generally not accompanied by structural reforms.

Secondly, several central price controls remained that should have been eliminated (the later the liberalisation, the greater the price jump). Thirdly,

in most of the countries the overvalued domestic currencies temporarily protect the country from imported inflation. It is a question how long this situation can be sustained as this may hamper exports and the development of competitive production, and affects the companies producing to the domestic market (due to the artificially low import prices).

Another probably positive sign is the relatively low general government deficits (except for Croatia). The relatively bal- anced budget is explained by the aban- donment of independent exchange-rate policy (Bulgaria) or the postponement of structural reforms (Serbia, Romania), and sometimes by the obligation to meet the conditions of the international institutions. However, an excessively fast decrease of deficit easily can have negative consequences (especially if the decrease was not accompanied by structural re-

forms; see the example of Croa- tia). On the other hand, fiscal consolidation plays a very important role in managing current- account deficits. However, without the implementation of structural reforms this is a stabilisation policy in vain as it results in lower GDP dynamics. Without growth impacts connected to structural change (reform) it is a question how growth could be quickened. The harmony between growth and balance is very difficult to find: in Bulgaria, own- ing to structural reforms and decreasing budget deficit, growth remained very quick; in Macedonia stabilisation was connected with slow growth while in Croatia imbalances increased parallel with the slowing of GDP growth.

Table 5

Average yearly inflation (%)

2000 2001 2002 2003 2004 2005*

Albania 0.1 3.1 5.2 2.3 2.9 - Bosnia-Herzegovina 4.8 3.1 0.4 0.6 –0.4 2.5

Bulgaria 10.3 7.4 5.8 2.3 6.2 4.5

Croatia 6.2 4.9 1.7 1.8 2.1 3.3 FYROM 5.8 5.5 1.8 1.2 –0.4 1.2 Romania 45.7 34.5 22.5 15.3 11.9 9.0 Serbia 79.6 93.3 16.6 9.9 11.4 15.0

* forecast

Source: Eurostat, national statistical offices

Table 6

General government balance (as % of GDP)

2000 2001 2002 2003 2004 2005*

Albania –7.5 –6.9 –6.0 –4.6 –4.6 - Bosnia-Herzegovina –7.0 –3.3 –0.2 0.8 0.4 0.0

Bulgaria –0.6 –0.6 –0.7 0 1.7 1.5 Croatia –6.5 –6.8 –4.8 –6.3 –4.9 –5.0 FYROM 2.3 –6.3 –5.6 –1.6 –1.3 –1.5 Romania –4.0 –3.2 –2.5 –2.3 –1.1 –1.0 Serbia –0.9 –1.4 –4.5 –4.2 –1.7 0.5

* forecast

Source: Eurostat, national statistical offices,

(8)

One of the most important character- istics of the regional economic processes is the high and further increasing foreign-trade deficit. Deficit is above 50%

of GDP in Bosnia, close to 30% in Ser- bia, and it ranges between 20-25% in Albania, Croatia and Macedonia, while it is “only” 10% in Bulgaria, Romania and Croatia. Foreign-trade deficit does not mean a barrier to growth until it can be financed from other sources (from other revenues or from riskless increase of foreign indebtedness). The very bad foreign-trade performance is not reflected entirely in the current account. Some of the countries obtain substantial revenues from services (Croatia, but Bulgaria too, started to receive increasing gains from tourism), and in other countries the large FDI inflow plays an important role. Imbalances are further mitigated by unilateral transfers from abroad. Such transfers are ranging between 13 and 25% of GDP in Ser- bia, Albania, Macedonia, Bosnia and Al- bania, meaning that these transfers play an important role in the currently experienced relatively fast growth and relative macroeconomic stability.

One may say that without the continuous huge inflow of FDI trade and current-account balances cannot be financed in the medium term. In addition, smooth development is only expected under these circumstances if foreign capital places emphasis on export-oriented development rather than on domestic-

market activities.

Although in recent years the capital inflow into the region has substantially increased, the real breakthrough only took place in Bul- garia, Romania and Croatia – in countries where EU talks have already required substantial adjustment, or where some unique conditions evolved. In

the other countries capital inflow could not exert an overall impact, certain services sectors and some well-positioned companies or branches became the target of FDI instead.

A common problem in the region’s countries is the appreciation of domestic currencies. This process in some countries is the result of the catching-up process and it is connected to the development of a more competitive economic structure. The strengthening of capital inflows also supports the appreciation.

The most important reason behind the appreciation is, however, the very large difference between domestic and foreign inflation levels. None of the countries eliminated this effect by depreciating the local currency since the fight against in-

Table 7

Balance of the current account and its components (as % of GDP)

Trade balance Transfers Current account 2002 2003 2002 2003 203 2004

Albania –21.9 –19.6 13.7 13.6 –6.7 –4.4 Bosnia-Herzegovina –58.4 –55.4 22.7 22.2 –24.5 –23.3

Bulgaria –12.5 –14.0 3.4 3.5 –9.2 –7.4 Croatia –27.3 –24.3 4.8 4.9 –6.9 –4.5 FYROM –18.4 –20.9 15.9 14.7 –3.3 –7.7

Romania –7.8 –9.0 4.0 4.2 –6.0 –7.5 Serbia –24.2 –31.7 12.1 15.3 –9.2 –13.1 Source: Central banks

Table 8 FDI (EUR million)

2000 2001 2002 2003 2004 2005*

Albania 155 232 151 158 275 - Bosnia-Herzegovina 159 133 282 338 400 400 Bulgaria 1103 903 980 1851 2114 1800 Croatia 1142 1503 1195 1788 921 1100 FYROM 189 493 83 84 122 90 Romania 1147 1294 1212 1946 4098 4000 Serbia 55 186 502 1197 775 1500

* forecast

Source: Central banks

(9)

flation and the maintenance of price stability is one of the most important economic policy objectives in this region, not least because of the bitter experiences with inflation during the nineties. This strategy is reflected in pegged exchange rates in many countries, and the countries with currency-board regimes do not even have an independent monetary policy. This situation in the future may in- fluence the flow of international capital as the overvalued currency with increasing production costs may weaken the attractiveness of these countries for FDI.

This could especially be unfavourable for the production and export of labour intensive products (a clear example is the already high-wage-costs Croatia).

In fact, each country in the region emphasises its willingness for long-term sustainable growth and the necessary structural changes. It can be seen, however, that the implementation of reforms in many countries depends on the conditionality approach practiced by the international organisations. This conditionality means EU adjustment to Romania and Bulgaria while in case of the other countries only IMF and donor coordinators can force to implement the necessary but unwanted reforms. Risks are also associated with the frequent ambiguities in privatisation policies and the manifest distrust of foreign capital.

* * * * *

(10)

P RIVATIZATION AND F ÔREIGN D ÎRECT I NVESTMENT ON THE B ÂLKANS

Miklós Szanyi

1) W HAT PRIVATIZATION IS GOOD FOR ?

Hungarian capital owners have the opportunity to invest abroad through participating in foreign countries’ privatization processes. Privatization was in some countries and in certain periods the primary tool of foreign investment. This will probably be also the case in some countries of the Balkans. Practice with privatization showed important differences in various countries, and so the extent and ways of foreign participation also varied.

It is therefore important to overview the background of privatization policies, first of all those political and economic goals that governments wanted to achieve, as well as the gathered empirical evidence up until these days.

Privatization was not invented in the transition economies. The idea of privatization first came up in the context of developed countries’ state-owned public- utility service sectors in close relationship with the mainstream economic thought typical for the 1980’s, principally with the neoliberal approach. The economic role of the state was do be reduced in general, hence the direct involvement through state-owned companies was regarded especially disadvantageous. The

companies that worked mostly on mo- nopolistic market conditions were regarded by critics inefficient. The expecta- tion was that a proper market regulation and the privatization together enabled firms to improve their operation. And if efficiency was not increased, losses were expected to be shifted over to consum- ers, thus state budget was still relieved from financing the losses or inefficient operation.

We must realize that the privatization tasks of transition economies largely differed from this neoliberal concept, which was also explicitly declared in the Wash- ington Consensus. Privatization in these countries spread to a more substantial part of the economy and affected very heterogeneous groups of companies from the sectoral, financial aspects but also regarding operational conditions. There- fore, the originally elaborated efficiency task of privatization did not came into the foreground in most cases. This pre- condition of meaningful privatization was treated by governments axiomatic. In practice the real impact of privatization on corporate operations of former state- owned firms was rarely reviewed. Where there was such review, it was always done ex post.

It is therefore not very surprising that governments of transition economies tried to achieve a number of other political

(11)

and economic goals through privatization, meanwhile they thought that operational efficiency of the privatized firms would improve automatically. Therefore, from the point of view of operational efficiency, undifferentiated privatization campaigns led to ever increasing func- tional disorders of privatized firms, even if new owners were private. Such problems sometimes forced governments to rethink privatization concepts, the due consideration of operational efficiency.

Sometimes renationalization and new privatization of former state companies was unavoidable.

But what other goals did governments try to solve through privatization? We must first mention the quickest and full- est possible elimination of political and economic structures of the previous communist regime. According to several renown economists and politicians the primary task of privatization in the transition economies was the marginalization of the political and economic exponents of the previous regime. We may also add, that the old cadres were to be replaced by a new elite. New cadres were to be supplied with adequate economic power. For example, in the former Czechoslovakia the new owners were expected to be the bourgeois middle class that the government wanted to strengthen (partly re-establish). In the Ukraine, just to mention another extreme policy, privatization was intended to directly support the new (?) political elite.

Active policy makers were the primary beneficiaries of the privatization process.

The main political content of privatization in most transition economies was therefore the direct or indirect political support of the new political elite.

Some forms of privatization induced substantial capital flows. State-budget revenues could be directly increased through incomes from privatization sales.

In case of selling to foreign investors the deal automatically improved also the current account. If additionally, governments used privatization revenues to re-

duce external debt, a third balance- improving effect was achieved. Privatiza- tion could therefore substantially improve the internal and external balance of transition economies.

2) P RIVATIZATION PRACTICES YESTERDAY AND TODAY

Governments of transition economies tried to facilitate the achievement of other important economic policy goals as well.

The priorities differed from country to country and in time, too. The applied privatization methods also varied. Before starting the analysis of the privatization methods it is important to emphasize the role of the time factor. More precisely, we state that identical privatization methods worked differently and pro- duced different results early in the transition process of Central and Eastern Europe than today. This has several reasons. First of all, countries in the second and third wave of the transition process already possess the experience of the forerunner economies. The Czech Repub- lic, Hungary and Poland applied rather different privatization methods, sometimes with success, sometimes without, and their experience is available now.

On the other hand, transition process has affected the economies of the Bal- kans for several years, even the least open Albanian and Serb economies. This means that governments have already started to solve the complex set of transition tasks. Some of these goals have been achieved or are being achieved.

Therefore, governments may devote more time and effort for the thorough elabo- ration of adequate privatization policies.

It is of course another question how much they can utilize this opportunity.

Most of the recent larger-scale privatization deals have resulted in much substantial privatization revenues received

(12)

for state-owned companies and their concessions than in the early phase of the transition process. This is also due to the fact that foreign investors gathered sufficient experience in Central and East- ern Europe, thus the investment risk of the region became moderate in the meantime.

But the time that has passed since the start of the transition process could also have brought some negative consequences for the privatization process. There are rather many state-owned companies on the privatization market that can be kept operational only with substantial subsidies from the budget. The privatization of such companies has become increasingly difficult. The social requirements (in terms of employment, supply security, etc.) that impeded their sale before have not been reduced. This way these companies have departed further from the norms of market economic principles. In some countries these anomalies are not isolated cases but regular practice. Com- petitiveness of the Ukrainian heavy industry was largely supported until recently through low energy prices guaranteed by bilateral agreements of Ukraine and Rus- sia. When the agreement was cancelled, Ukrainian economy was threatened with immediate collapse. Similarly, in neighbouring Romania, up until the last phase of the EU accession negotiations, it was not clear if state paternalism or market-driven competition would determine economic actions. We can observe the same dilemma in the countries of the Western Balkans. After introducing these systemic aspects of transition we can turn our attention to the different privatization methods that may play a role in the countries of the Balkans.

Best known from the Hungarian practice is tender sale to high bidder, regarded as the most suitable method to find “real owners” that are adequate for the future needs of the privatized companies. This can be domestic or foreign investor alike. Preference of one against the other depends on the general priori-

ties of governments. Very often governments reject foreign participation in privatization, or they allow it only in form of direct sales or invitation tenders. The exclusion of foreign participants may be disadvantageous from several aspects (lower sales revenue, less available capital for reorganization investments, weaker international competitiveness, etc.). Domestic investors pursue usually smaller adjustments in corporate activity that results in smaller drop in employment, and a more likely retaining of at least parts of the former supplier net- work, which can be rather beneficial for the economy as a whole.

The other main advantage of the tender sale against other privatization techniques is the higher revenue that can be collected by the state budget from the sales transaction. It is important also from this point of view that the transactions are transparent and monitored, and corruption is reduced as much as possible. In fact, Balkan countries are in a favourable position in this regard. Priva- tization is not a quick campaign. More time and effort can be devoted to the individual sales procedures. The problem here is therefore not a technical one but intentional: governments want to control and direct the redistribution of state assets. There is no political will in many cases to organize open tender sales because not the economic but the political rationale determines the process of privatization. There were several cases when liabilities of state companies were not fully listed prior to signing of the privatization contract, which would have been unavoidable in case of an open tender process. Since there is no major privatization sales campaign, privatization tenders usually achieve high sales prices now.

During open tenders foreign investors also may have an opportunity of participation. In the case of other privatization techniques there are only indirect possi- bilities of foreign participation. Like in Hungary, also in the Balkan countries

(13)

the application of tender sales very much depends on the actual situation of the state budget and levels of external indebtedness. If there is no alternative solution of restoring budget equilibrium it is very simple to use privatization revenues for this purpose. From this aspect situation of Croatia and Serbia can be regarded as critical. Though in case of Serbia collective ownership models of state manufacturing industry makes privatization especially difficult also from the technical, judicial point of view. The situation is similar here to some problems of Polish privatization where exten- sive worker participation as well as the special status Solidarnosc makes it difficult to sell some state-owned companies.

The Hungarian experience also showed the importance of the active participation of corporate management in the process of privatization.

The second basic privatization method is the distribution among the population coupons that represent ownership rights in state properties. This method can also be interesting for foreign investors, since though indirectly, this also enables them to participate in the privatization process.

The main aim of this method was to create and strengthen the wealth of the middle class through the gratis distribution of vouchers. However, large parts of the middle class did not want to become bourgeois and did not care much about the received ownership. Huge amounts of the coupons were sold to various agents before transferring them into real property. The concentration of real property rights continued after the transfer of coupons for corporate securities. In many cases controlling shares of the securities ended up in the hands of insider investors. Depending on details of regulation foreign investors could also establish companies that could participate in the collection of vouchers and corporate securities. Another opportunity of foreign participation was to purchase the collected securities from domestic funds.

The essence of the privatization process

through coupons was that despite of government will and the inclusion of several intermediate stations, ownership rights were concentrated and transferred to either domestic or foreign strategic investors.

Voucher privatization postponed corporate adjustment process considerably.

First-tire owners lacked devotion, skills as well as the necessary capital for active participation in corporate governance and adjustment. Coupons were collected primarily by agencies of state-owned banks in the Czech Republic. They were the same banks who were the major creditors of the “privatized” companies.

In these cases the otherwise separated roles of the owner, creditor and policy maker interfered thus intensifying oppor- tunism and in many cases also corruption. The result was continuous deterio- ration of market positions and financial conditions of these firms. In the later phase of the privatization foreign investors also had to recover the accumulated financial and adjustment deficits. The political goals of voucher privatization were not achieved either. The incumbent management remained in position in most cases. Insiders could even strengthen their position through the voucher privatization.

There is, however, another, much less complicated and cheaper way of insider privatization. This is the simple distribution of state property among the clientele of the new political elite. This type of

“client-privatization” becomes important in all those countries where there are no serious democratic traditions and institutions (like in the CIS countries), or where privatization was started before setting up the democratic institutions (like in the Western Balkans). It is need- less to analyze very long how much danger “client-privatization” means for corporate restructuring, institution building or the credibility of economic policy.

Also, from the point of view of foreign investment this is the worse solution. Di- rect participation is almost impossible or

(14)

bound to heavy corruption. The risks of indirect participation in form of buying out from the clientele are very high, too.

In some countries, due to the absolute lack of democratic institutions, political leadership possesses state companies as if they were their own personal property.

This situation is similarly not transparent and corrupt as the previously mentioned client-privatization. In such countries not only ways of obtaining property but also the basic legal conditions of corporate functioning are not clear or not properly regulated. It is therefore very difficult to obtain digestible information from state companies, since they work under conditions that can change entirely after transforming ownership. Foreign investors restrain their interest in these countries to capturing markets, hence they can obtain concession for operation only if they purchase together with the concessions the local service supplier. The brave pioneers are sometimes rewarded by very high revenues. If previous market conditions are kept after privatization (e.g. market protection) an improvement in productivity and efficiency may bring very high rates of return on investment in these cases.

There are further less important but not negligible methods of privatization.

Assets of state firms can be purchased in bankruptcy procedures. Manage- ment/employee buyouts were also frequent. There was some kind of restitution in each transition country and many of them had campaigns of “small privatization” (sale of retail shops, small workshops). In some countries these methods obtained more emphasis. For example, in Poland privatization through liquidation led to the actively controlled privatization method of several hundreds of companies. Employee buyouts may play an important role in Serbia, where this privatization method can be “sold”

as a clear continuation of the strong collective socialist ownership patterns. Ex- periences with employee ownership in Hungary suggest, however, that this is in

many cases an intermediate step of transferring property to strategic owners, or to insider privatization (i.e. management buys out employee ownership).

Lastly there is also the option of privatization through the stock exchange but this method may not receive serious attention on the Balkans, since capital markets of these countries are rather underdeveloped and there are only very few firms to qualify for public offering.

3) P RIVATIZATION AND

FOREIGN INVESTMENT ON THE B ^ALKANS

Foreign direct investment attraction depends largely on privatization policies wherever there is still substantial state property in the region. Bulgarian privatization has continued uninterrupted since 1997, where almost 90% of the state property that was foreseen for privatization has already been privatized. On the other hand one third of all state property was kept in state management. This means nearly 600 companies, with majority state ownership in 63 companies.

The main task of the coming years will be the reduction of state-ownership shares. This will affect mainly the electricity sector, travel, military industry and cultural institutions. The energy sector is under reconstruction according the EU norms. Production and servicing is separated into different companies. NEK (the energy supplier) and Bulgargas is expected to be privatized in 2007. The rather politicized privatization of Bul- gartabac may also be completed earlier.

A privatization sales campaign in the Romanian services sector is expected in the near future (regional energy and gas suppliers). Issues of bank privatization are also topical. AVAS privatized 62 larger and medium-sized firms in 2004,

(15)

but there are over 1500 companies in the agency’s portfolio. The accelerated privatization of these firms is expected shortly through the involvement of foreign investors.

It is more difficult to foresee the future speed and extent of privatization in Croatia. The Privatization Fund possesses 1100 firms at present, one third in manufacturing, one third in services and tourism, and there are also over 100 companies in the construction business.

Previous privatization transactions did not prefer foreign participation. The new owners became the employees of the companies, the state pension fund, as well as citizens who received property in restitution. Bigger items are the HEP electricity supplier company, Osiguranje insurance company, as well as numerous firms in the heavy industry, including shipyards (many of them are heavily in- debted). Similarly, much state-owned real estates (bound to tourism) could be sold.

Currently it is not clear whether the Croatian government decides to open for foreign participation or continues the previous domestic-oriented practice.

Serbian prospects are parallel with the Croatian experience largely due to the common heritage. Privatization was started here very late, only in 2003. Ac- cording to the most current privatization plans 70% of state property is to be sold to strategic partners, and employees can buy out a further 15%. Especially important could be privatization in the energy sector, in the chemical industry, food industry and in services. Foreign investments are needed also in the renovation of the badly damaged or destroyed lin- ear infrastructure systems. Currently, state firms are prepared for later privatization, but the sporadic concrete privatization experiences in Serbia show rather limited level of commitment in favour of foreign investors. Most current negative example is the case of the Nis oil refinery, the majority ownership of which was sold to foreign investors. Af- ter signing, the conditions of the contract

were changed by the government reducing foreign ownership to a minority share. The foreign investor naturally withdrew from the deal. Important part of the preparations is clearing corporate- asset portfolio from non-performing claims. The writing off of debts should limit payment arrears in the Serbian economy.

Generally speaking, in the next future, the amounts of foreign direct investment will largely vary among the countries of the Balkans. One component of the potential level is the size of available state property that can be privatized (also depending on the quality of assets), the other is the willingness of governments to open up privatization process to foreign investors. The political will is deter- mined by general political goals, and by the public perception of selling assets to foreign investors. In the new EU mem- bers, as well as in those countries that will most probably join the Union in 2007, quick and decisive privatization actions are expected because it is implic- itly required in the process of taking over the aquis. In other countries, however, the process may be substantially slower and more controversial.

From the viewpoint of the development and modernization of Balkan countries’

economies privatization and foreign investment may play a crucial role. From the angle of sustainable development and capital attraction, privatization investments, greenfield investments and the reinvestment of locally generated profits are regarded rather differently. The high peaks in the FDI records of certain countries are mainly attributed to one or a few major privatization deals. The pool of privatization is exhausted by time, thus, FDI attraction cannot be based on lucrative privatization offerings for ever.

Substantial privatization opportunities still exist in the Balkan countries, but the sale of big business has been started in Romania and Bulgaria, reducing potential future stock. On the other hand, Croatia

(16)

and Serbia do not pursue FDI-friendly privatization policies.

Comparing the composition of FDI stock, though there are big differences across countries and years, FDI stocks are still largely dominated by privatization deals. Nonetheless, the yearly inflow figures sometimes show the priority of greenfield investments. In case of Bul- garia one can observe the change of tendencies that the forerunner transition economies experienced 5-8 years ago.

Greenfield investments together with rein- vested profits and loan-financed expan- sions of existing facilities contributed to some 70% of the capital stock in 2005.

In Romania large privatization revenues (Petrom in 2004) limited the relative share of greenfield investments. But out of the 56 received investment applications in the first half of 2005 35 aimed greenfield projects or the expansion of capacities. On the other hand, in the ex- Yugoslav countries (less Slovenia) no major greenfield investment has been carried out up until recently. Croatian sources state that some 20% of FDI inflow was greenfield investments, but they were mostly small-scale projects, employ- ing less than 4% of manufacturing labour. In the case of Serbia there are two major greenfield investments in the services sector.

The sectoral penetration pattern of FDI in the Balkan countries is rather mixed. This heavily depends on pursued privatization policies. In most countries there have been strategic branches of the economy, or at least firms of strategic importance that should not be opened up to foreign investment (energy sector, banking sector, most of the communal services, some manufacturing branches).

On the other hand, the structural composition of FDI also depends on the sectoral patterns of the host economies.

There are, for example, large investment projects in tourism in Bulgaria and Croatia. The importance of structural patterns is evident if we compare Bul- garia and Romania. Romanian FDI con-

centrates on manufacturing, meanwhile the share of manufacturing investments in Bulgaria is only 24%. It is telecom, trade and the energy sector which are more deeply penetrated in Bulgaria.

Croatian FDI structure is more similar to the Bulgarian with the reservation that joint ventures (with minority foreign ownership) play an important role in Croatian FDI stock. The structure of the limited Serbian FDI stock, on the other hand, is similar to the Romanian. Out of the 15 largest privatization investments, 10 were carried out in manufacturing.

Beneficial effects of privatization and FDI can be illustrated by the structural changes of the economies. Following the 1997 stabilization efforts FDI inflow in- tensified in Bulgaria and resulted in ob- servable structural change and increasing export performance. Romania still fights with rather serious structural problems that have to be solved before joining the European Union. Privatization may play an important role in this process. On the other hand, structural adjustment will also require the closure of many large state-owned companies thus increasing unemployment in several regions. With- out the current intensive subsidization these companies cannot survive. Croatia and Serbia are not forced to eliminate direct subsidization of ailing state firms.

Surviving state paternalism is coupled with a less FDI-friendly political environment. Hence, on the one side, the elimination of inefficient activities is not en- forced, on the other, the creation of new structures by FDI is not supported. The outcome of long-term structural rigidity can be predicted. A clear sign of structural weakness is the 10,000 Croatian firms that are regarded illiquid. Payment arrears in the country achieve USD 2 billion. In Serbia not even the pre-war levels of economic activity were achieved until recently.

Even if we expect successful economic policies in these countries the current high level of unemployment will not be reduced substantially on the short run.

(17)

Due to belated privatization unemployment will most probably even increase.

Most unemployed in these countries are unskilled, and they have therefore only limited chances to obtain jobs in interna- tionally competitive sectors. The problem cannot be solved with ad hoc measures.

Privatization contracts may set employment conditions, but on the longer run levels and structure of employment will be shaped according to the needs of the private owners. The short-term consequences of maintaining excessive employment limits international competitiveness and reduces the chances for successful restructuring. The problem is worse if domestic owners act and there is employee ownership. Foreign companies developed their practice how to over- come employment conditions, shaping extent and structure of employment according to their needs. If employment requirements are too strict foreign investors simply withdraw.

Hungarian companies pursued different strategies in their investments abroad.

Some companies tried to buy majority ownership at once (e.g. OTP), others gradually increased their ownership share, also according to the availability of state assets. Such step-by-step approach is plausible in countries with

investment restrictions, for example in Croatia. Since investment restrictions are fully in contrast with EU regulations and principles, the elimination of them can be expected in all those countries that are serious in their aim of becoming mem- bers. Hungarian investors invested the largest amounts, mainly in the privatization process. Out of the 10 largest Hun- garian outward FDI projects 9 were privatization related. More sizeable manufacturing investments, on the other hand, are shared between privatization and greenfield projects. Videoton purchased a factory in Bulgaria, meanwhile Pannon- plast and Dunapack established new greenfield investments in Romania and Croatia, respectively. Most of the small investments belong to the greenfield category. In case of the small investments there are no ownership restrictions even if bigger investments or privatization deals are strictly regulated and controlled (Croatia, Serbia). Hungarian investors experienced problems mostly in Croatia (not in Serbia, because there are only a few Hungarian investments, yet).

Most of them were related to property rights. The lack of clear rules and regulations of obtaining property is a major barrier of investment.

* * * * *

(18)

T ^HE R ELATIONS OF THE E ^UROPEAN U ^NION

WITH THE B ^ALKAN C ^OUNTRIES *

Tamás Szemlér

I NTRODUCTION

For the European Union (EU), the political and economic stability of the countries in its direct neighbourhood, as well as the calculable development of its relations with these countries is of great importance. The development of the external relations of the EU in the last decade is characterised by the institu- tionalisation and structuring of these relations.

The above statements are especially valid for the countries of the Balkan peninsula. After the economic recession following the systemic change and, in the case of former Yugoslavia, the armed conflicts, the EU has become very interested in the stabilisation of the region. It has already been clear at the creation of the structured system of re- lationships that the countries of the region differ from each other to a great

extent regarding the level of their economic development, political stability and democracy – all these aspects are crucial from the EU point of view when it considers establishing closer institutional- ised relations with a country.

Due to this heterogeneity of the region, we find here countries which are already at the threshold of EU membership (Bulgaria, Romania), a country which could already open the negotiations on its accession (Croatia), while the other countries are much further from full EU membership, and are connected to the EU by other contractual relations (or just work on formulating these ties).¹

This paper presents an overview of EU relations with the Balkan countries.

In what follows, we deal separately with the countries having already concluded their accession negotiations (Bulgaria and Romania) and the other countries.

(These latter have the common feature of participating in the Stabilisation and Association Process (SAP) for the West- ern Balkans. Besides the bilateral relations with the EU – but definitely not

1 Slovenia, a former Yugoslav Republic is an EU member since 2004. Thus it is much more advanced in this respect (among other respects) than the countries observed here. In this paper we do not examine the EU-Slovenian relations.

* This paper has been prepared in the framework of the OTKA research No. 038289, “The European Union and Its Direct Neighbourhood beyond Enlargement”.

(19)

independently from them – we also dis- cuss the actual situation and future prospects of regional cooperation.

1) T HE COUNTRIES AT THE THRESHOLD OF EU

MEMBERSHIP

The leaders of two of the Balkan countries – Bulgaria and Romania – have already signed the treaty on EU accession. The expected date of the entry of these countries into the EU is 1 January 2007, but this date can be postponed in both cases if the EU finds that the country does not comply wholly with EU requirements regarding the preparation for membership and related reforms.

Despite the fact that Romania has made steps in bilateral relations the ear- liest – it was the first country of the Soviet bloc establishing official relations with the European Communities –, at the beginning of the 2000s, both countries were on the same track regarding their EU relations (Table 1).

The EU has provided financial support for the social and economic development of the two countries (a pre- condition of tightening the relations).

Until 2002, Bulgaria has received about 1.35 bn euros of support in the framework of the PHARE Programme; the framework for 2003 was 94.9 million euros for national programmes, and 28 million euros for cross-border cooperation; for 2004, respectively, 172.5 million euros and 36 million euros were available for Bulgaria from PHARE resources. Concerning the two newer pre- accession funds (ISPA and SAPARD, both are in operation since 2000), Bul- garia has received about 463 million euros ISPA and 287 million euros SAPARD support until 2004. Romania –

Table1

The relations of Bulgaria and Romania with the EU – the main steps

Year Bulgaria Romania

1974

Romania’s inclusion in the Community's

Generalised System of Preferences 1980

Signing of the Agreement on In- dustrial Products

1990

Bulgaria and the European Eco- nomic Community signed the Agree- ment on Trade and Cooperation;

the PHARE Pro- gramme was opened to Bulgaria

1991

Signing of the Trade and Co- operation Agree- ment; the PHARE Programme was opened to Romania

1993

March: the Europe Agreement for Bulgaria and the Interim Agreement on Trade and Re- lated Matters were signed

February: the Europe Agreement for Romania and the Interim Agreement on Trade and Related Matters were signed

1995

February: entrance into force of the Europe Agreement December: application for EU membership

February: entrance into force of the Europe Agreement June: application for EU membership

1999

December: Helsinki European Council's decision to open the accession negotia-

tions

2000 February: formal beginning of the accession negotiations 2004 December: closure of the accession ne-

gotiations

2005 April: signing of the Accession Treaty in Luxembourg

2007

January 1 – planned accession date;

delay by 1 year is possible if preparations are not continued Source: European Commission

(20)

due to its considerably bigger size (especially concerning population) has received much more substantial financial support than Bulgaria: the total amount of EU transfers to Romania in the framework of the three above programmes until 2004 exceeded 4.8 bn euros. Support for 2004 exceeded 900 million euros (from the total amount of 908 million euros, 433.3 mn euros belonged to PHARE [from this, 405.3 million euros for national programmes, 28 million euros for cross-border cooperation], 158.7 million euros to SAPARD, and 316 million euros to ISPA).²

EU support assures important financial resources for both countries: in the period 2004–2006, each year, this support equals to about 2% of GDP in Bulgaria, and 1.5% of GDP in Romania.

After accession, EU financial support for both countries is expected to show a considerable (although partly gradual) increase.

2) T HE COUNTRIES OF THE

S TABILISATION AND

A ^CCESSION P ^ROCESS

The SAP is the framework programme of the EU for Albania, Bosnia- Herzegovina, the former Yugoslav Re- public of Macedonia and Serbia- Montenegro including Kosovo as defined by the UNSCR 1244. Although Croatia has begun its accession negotiations with the EU in October 2005, it also partici- pates in the process. This is in line with the important principle that the SAP is the policy of the EU towards the countries of the Western Balkans throughout

2 Source of data:

http://www.europa.eu.int/comm/enlargement/bulg aria/eu_relations.htm,

http://www.europa.eu.int/comm/enlargement/rom ania/eu_relations.htm.

the whole process of their full integration into the Union.

The SAP is a long-term process, pro- viding a general framework for the countries of the region for their relationship with the EU, and at the same time it takes into account the differences in political and economic development between them (both the general framework and the differences can be followed in Table 2). By launching the SAP, the objective of the EU is to as- sure the conditions of peace, political stability, freedom and economic development in the region. In order to reach these objectives, the EU proposed the countries of the region the prospect of full membership; the most important milestone on the road leading to this objective is the Stabilisation and Associa- tion Agreement (SAA) for each country.

For the SAP countries, the EU pro- vides “country-shaped” combinations of trade concessions (Autonomous Trade Preferences), economic and financial support (the CARDS programme; see Table 3), and contractual relations. Be- sides bilateral relations, the encourage- ment and support of regional cooperation is also an important element of the structure of relations in the framework of the SAP.

The SAP launched in 2000 (at the EU–Balkans summit held in Zagreb) has received new impetus at the Thessaloniki European Council in 2003, which, by approving the “Thessaloniki Agenda”, reinforced the SAP as the policy of the EU towards the Western Balkans, and confirmed the EU integration prospects of the SAP countries, as well (the countries participating in the process can join the EU, once they will be ready for it).

(21)

Table 2

The relations of the countries of the Western Balkans with the EU – the main steps

Year Albania Bosnia-Herzegovina Croatia Macedonia-FYROM Serbia-Montenegro

1992

Trade and Cooperation Agree- ment between the EU and Alba- nia. Albania becomes eligible for

funding under the EU PHARE Programme

April: Bosnia-Herzegovina de- clares independence – the civil

war starts

1995

November: the Dayton Peace Agreement puts an end to the

war

1996

The former Yugoslav Republic of Macedonia becomes eligible for

funding under the EC PHARE programme

1997 Regional Approach. The EU Council of Ministers establishes political and economic conditionality for the development of bilateral relations

1997

April: Signature of a Cooperation Agreement and financial protocol to promote global co-operation;

Agreement on Trade in Textile Products; Agreement in the field

of Transport

1998

June: EU/Bosnia-Herzegovina

Consultative Task Force is established

The Cooperation Agreement and the Agreement in the field of

Transport enter into force 1999 The EU proposes the new Stabilisation and Association Process (SAP) for five countries of South-Eastern Europe 1999

Albania benefits from Autono- mous Trade Preferences with the

EU

2000 June: Feira European Council (June 2000) states that all the SAP countries are "potential candidates" for EU membership November: At Zagreb Summit, the SAP is officially endorsed by the EU and the Western Balkan countries

2000

Extension of duty-free access to EU market for products from

Albania

October: Fall of the Milosevic regime. November: “Framework Agreement FRY (Former Republic

of Yugoslavia)-EU for the provi- sion of Assistance and Support

by the EU to the FRY”. Serbia and Montenegro benefits from Autonomous Trade Preferences

from the EU

INSTITUTE FOR WORLD ECONOMICS HUNGARIAN ACADEMY OF SCIENCES W o r k i n g P a p e r s